Two alternative payment arrangements are for an organization to hire a doctor on contract (practiced by mutual aid societies, unions, and some employers) or for an individual to have a prepaid plan with a particular group practice (Chapin 2015). These arrangements have essentially the same incentive structure for both consumers and doctors. If an organization hires a doctor on a fixed salary contract, the doctor benefits himself the most by treating the patients as minimally as possible, possibly given some minimum quality threshold. Because the patient faces zero (or near zero) marginal cost for seeing the doctor, the patient benefits the most from visiting the doctor more than if he faced the full marginal cost of the visit. This contrasts with the fee for service where the doctor has the incentive to overtreat.
These different types of pay contracts open up new avenues of competition, but the potential impediments to consumer shopping are still inherent in the market. Consumers may not have enough information about the quality of the doctor or fully understand the prepayment contract, and search and switching cost are not mitigated by these contracts, per se. The main benefit of this model is that, even though consumers still do not face the full marginal cost of seeing the doctor, the doctor’s incentive is to minimize the amount of care, which reduces the cost of service. This leaves more room for the possibility of price reducing competition, but even if two prepaid group practices open up next to each other, the consumer still faces impediments to shopping effectively. We can still imagine a scenario in which consumers face lower search and switching costs and can counteract the incentive of the doctor to undertreat them. We will examine how mutual aid societies’ contracts with doctors solved the problems of search costs and informational asymmetries.
Mutual aid societies (or lodges) hired doctors on a fixed salary basis and generally charged members a $2 annual fee that covered doctor’s services but not the cost of medicine (Beito 2000, 111-12). This fee was approximately a day’s wages for a laborer and was around the same price as one nighttime house call from a non-lodge doctor. Lodge doctors were elected by members of mutual aid societies on a yearly basis, which meant that every year they had to compete with other doctors to get the lodge contract.
The fixed salary contract paired with the hiring through election provided the main benefit of the structure of lodge doctor contracts. With access provided through membership in the lodge plus the annual fee, the price the consumer faced for seeing the doctor was near certain. Hiring by election acted to publicly reveal the quality of the lodge doctor, so at least the quality of the incumbent doctor was more easily verified than if the consumer were to shop for a doctor on his own. Thus the informational asymmetry between doctor and patient was substantially reduced,13 and the bidding process reduced the cost of searching for another physician. Because this was a yearly process, the doctors were never far removed from competition. Additionally, lodges also competed for members by having lower mortality rates (119). They would advertise the mortality rate of lodge members compared to the mortality rate of the local population, so there was at least some incentive to hire doctors of at least a minimum sufficient quality.
The social aspect of the mutual aid society encouraged discussion of the lodge doctor among members. Thus, when it was time to elect the lodge doctor, the information obtained by members who sought care during the year and the information gathered by those who talked to those patients during the year is aggregated in the outcome of the vote (Arrow 1951). There are potential drawbacks to this way of choosing the doctor. Someone may start rumors to discourage the rehiring of the current doctor in order to facilitate the hiring of another doctor, or a lodge leader may manipulate the choice of alternatives in order to obtain a particular desired result.
While the hire-by-election system may be imperfect, due to who nominates the doctors and whether the doctor has personal relationships with the lodge members, the question remains as to whether it is better than the relevant alternatives. One alternative is hiring-by-appointment (rather than election). This option is potentially just as prone to manipulation as election, but it does not have the same beneficial information revelation potential. Another alternative is to not hire a lodge doctor and have members purchase medical care individually. While an individual patient could consult his social network for recommendations, having a yearly assessment of one particular doctor by a large group may yield more information. This alternative also abandons the benefit of bargaining as a large group, which lowers the cost to the individual patient.14
Due to the fixed salary payment scheme, extra doctor’s visits did not impose additional costs on the lodge or its members, and the hiring-by-election system incentivized the doctors to respond in a timely manner to requests from lodge members. Not only did the fixed salary payment encourage members to contact the doctor at the onset of an ailment, leading to quicker treatment, but it also encouraged doctors to practice preventative medicine. Because doctors incurred a personal cost and no extra revenue every time they saw a patient, it was in the doctors’ best interest to do his best to cure the patient as quickly as possible.
Both the practice of lodge doctors and prepaid groups were competitive threats to existing solo practice physicians. Local medical societies led the way in the fight against the practice of lodge doctors. Because of the fixed salary payment, lodge members could see the lodge doctor for much less than seeing a non-lodge doctor. This put downward pressure on prices that non-lodge doctors could charge. To give an idea of the reach of the lodge practice, Beito (2000, 111) notes that in Seattle about 20 percent of males over age twenty-one had access to a lodge doctor. Lodge doctors represented a significant competitive threat to doctors outside of mutual aid societies. In the second decade of the twentieth century, local medical societies not only withdrew some lodge doctors’ memberships but also led boycotts against the lodge doctors. Revoking a doctor’s membership or not admitting the doctor altogether impeded a doctor’s ability to obtain malpractice insurance (Chapin 2015, 23). These boycotts took the form of not aiding or consulting with the lodge doctor. This would reduce the ability of a lodge doctor to provide good-quality service, especially for a difficult medical case. Medical society members also colluded to have lodge doctors admitting privileges to local hospitals revoked. This further reduced the lodge doctor’s ability to provide a high quality of service to lodge members. State medical societies also charged lodge doctors and doctors in prepaid group practices with various ethics violations, leading to some doctors losing their licenses.
The efforts of local medical societies were successful in part due to the increasing restriction on the supply of doctors and due to the monopolies the state medical societies had over certification of doctors. With a monopoly over granting licenses to doctors, state medical societies could credibly threaten doctors who engaged in the various alternative payment arrangements discussed above. The ever tighter certification requirements on doctors and medical schools led to a much lower rate of doctors in the population, from 164 per 100,000 people in 1910 to 125 per 100,000 in 1930 (Beito 2000,
128). This increased the cost of hiring a lodge doctor and enabled local medical societies to have a tighter grip on the market for doctors’ services.
Given the reduction in the membership in mutual aid societies and the fragmentation and price inflation of health care, the type of arrangement provided by the mutual aid societies may be infeasible today. The benefits of mutual aid societies in the health care market were largely dependent on the social nature of those groups. Individuals who were embedded in particular social networks15 collectively made the choice of doctor. The market for doctor services has changed dramatically since the beginning of the 1900s due, in part, to increased regulation of licensing and increased specialization that comes with increased knowledge. The lodge doctor practice does, however, provide us with general lessons of how payment contracts for health care that enhance consumers’ shopping capabilities can be structured. In order to reduce information asymmetries, there must be some way to aggregate data on the doctor. The threat of the consumer exiting the doctor-patient relationship must be credible. This ensures that the doctor is under competitive pressure. Mutual aid societies achieved these goals through yearly elections of the lodge doctor. The doctor also faced cost minimization incentives while still maintaining sufficient quality, which was achieved through the combining of a fixed salary with the yearly election. While there is now less opposition to fixed-fee contracts with the success of companies like Kaiser Permanente and Geiringer Health System, the ease of consumer switching and lower search costs remain pertinent goals. In the next section I discuss the example of medical tourism and how this may provide a way of translating the lessons from mutual aid societies to the present day.